In its simplest form an indemnity is an agreement between two
parties in which one party agrees to cover loss and damage suffered
by another. As such indemnities are a very effective tool to
allocate risk between transacting parties. The risk we are talking
about is the risk of something specific going wrong, and the
allocation of that risk being who has to pay for it.
For example a contractor may agree to indemnify the principal
for loss the principal suffers as a result of the contractor
damaging the principal's property during construction
WHY DO I NEED AN INDEMNITY TO RECOVER LOSS I SUFFER?
You don't. But if you don't have the benefit of an
indemnity the amount you recover from the offending party may be
less. This is because the innocent person will need to rely on the
remedy of damages to recoup its loss.
Under a damages claim the loss may not be recoverable
the loss arises naturally as a consequence of the breach;
the loss was foreseeable at the time of the contract;
the innocent party can demonstrate that it has taken
appropriate steps to minimise their loss.
A carefully drafted indemnity will not be constrained by the
above factors because indemnities are not governed by the law
relating to damages. So the inclusion of an indemnity and how it is
drafted can have significant financial implications on the party
granting the indemnity if anything goes wrong.
THINGS TO LOOK OUT FOR WHEN NEGOTIATING INDEMNITIES
Look to see how narrow or broad the scope of the indemnity is
by looking for words such as loss directly caused by an
event compared to loss in connection with an event. The
latter being a lot broader will result in more loss being
Check to see if the indemnity relates to loss caused by any
breach of contract or whether it is limited to damage to the
innocent person's property or injury to its people. Caution
should be used if asked to indemnify for any breaches of contract
because it will result in far greater liability being assumed by
the person giving the indemnity i.e. effectively all loss suffered
by the other person can be recovered on an indemnity basis as
opposed to only specific losses.
The provider of an indemnity should always seek to include a
clause which expressly excludes them from being responsible for any
consequential or indirect loss (such as loss of profit or
opportunity) that the recipient suffers. This is often regarded as
a reasonable request.
COMMERCIAL AND PRACTICAL CONSIDERATIONS
Every commercial arrangement is unique. Whether or not a party
proceeds with an agreement under which it grants an indemnity will
depend on both the risk posed by the indemnity and the importance
of the overall deal to the party. In analysing the risk it will be
up to the indemnifying party to consider both the probability of
the indemnified event occurring and the consequences of the
indemnity, including effects on its insurance cover. It is also
important to be realistic and take into account the capacity of the
party giving the indemnity to meet the obligations of the
A broadly worded indemnity clause will be useless to an
indemnified party if the person giving the indemnity does not have
the financial resources to make good on its obligations to pay the
In short, be commercial about the way you go about negotiating
indemnities. Identify the risk, assess it from a commercial
perspective and negotiate accordingly. In business it's all
about keeping deals on track, keeping the momentum going.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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We discuss whether certain clauses commonly found in ordinary commercial contracts could be considered to be penalties.
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